Equity income: Shelter from the storm

JustinWiser

WASHINGTON (CBS.MW) - Investors looking for any port in a storm might want to dock some assets in equity-income funds.

The yields of these funds, which emphasize dividend-paying stocks, have provided a valuable cushion during the current bear market. Yet it's not just the high yields that make them attractive.

"The actual magnitude of the yield may not be that important to investors," Morningstar analyst Brad Sweeney says. More important is the nature of the companies that equity-income funds seek out.

"If you have a portfolio of names that are paying dividends, you have a portfolio of names that are mature companies, stable firms that are less volatile than the general market," Sweeney says.

These cash-generating companies have the resources to weather an economic downturn better than many of their younger peers. In general, they're not highly leveraged and carry relatively light debtloads.

A concentration in staid, dividend-paying names helped Ark Equity Income fund
AREIX
to a 13.7 percent return in 2000, beating the S&P 500 index by 23 percent. "Defensive names tend to do well in this environment," co-manager Allen Ashcroft says.

Ashcroft has loaded the fund with large value stocks, many in the financial, energy and REIT areas. "You would probably know almost every security in the fund," he says. "We're not taking a lot of risks here."

The Ark portfolio stock with the largest dividend is Knightsbridge Tankers
VLCCF
a Bermuda-based firm that leases and charters crude oil tankers. Ashcroft expects a 14 percent yield from the stock for the year.

Other high-yielders in the portfolio include utility names and REITS like Boston Properties
BXP, -0.40%
Ashcroft says.

The typical equity income fund is bound to hold at least 65 percent of assets in income-producing stocks and/or to achieve a portfolio yield 25 to 50 percent greater than that of the S&P 500.

Morningstar and other data sources don't track an official "equity-income" category of funds. The funds, which exclusively hold stocks, normally fall in the growth & income class, which includes balanced funds that also hold bonds and larger percentages of cash equivalents.

When researching an equity-income fund, investors must determine if the fund does indeed generally buy stocks that pay dividends. Ark Equity Income has an "unwritten rule" that it won't hold stocks that don't pay a dividend, and a review of its holdings confirms that.

Alliance Growth & Income
CABDX, -0.17%
on the other hand, has a yield of only 0.94 percent, even less than the S&P 500's historically low current yield of about 1 percent.

"Mangers may meet their income requirement by 'barbelling' the portfolio with a handful of large dividend-paying names or debt securities" and focus the rest of the portfolio elsewhere, Sweeney says.

Many growth and income funds also lowered yield requirements in recent years to give them access to once high-flying tech shares such as Microsoft and Cisco Systems, which don't pay dividends.

Two of the oldest and best-known equity-income funds are Vanguard Equity Income
VEIPX, +0.22%
and T. Rowe Price Equity Income
PRFDX, -0.09%
Both opened in the 1980s -- and both rose more than 13 percent last year.

Other equity-income funds with good track records include Janus Equity Income
JAEIX, +0.00%
and Fidelity Dividend Growth
FDGFX, -0.28%
which boasts an annualized five-year return of 22.5 percent.

Traditionally, blue chip stocks from the financial, drug and utility areas have paid the largest dividends. A recent screen of large cap stocks for the highest-yields revealed 12-month figures of 8 percent for PG&E Corp.
PCG, -0.05%
and Xerox
XRX, +0.29%
5.7 percent for First Union
FTU, +1.25%
and 4.7 percent for DaimlerChrysler
DCX

The 12-month-yield of the S&P 500 is only about 1 percent now, according to Morningstar. "It's become unfashionable for firms to pay out dividends," Sweeney says. "A lot of it is a consequence of the tax laws."

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